Money Demand a Function of Private Consumption Spending, Not Income

Note to Self: I alway find it interesting that Friedman and the monetarists formulated money demand as a function of income rather than of private spending, or even of private consumption spending. You don’t need or want money when your income is high, unless you want to spend it.

And it seems highly likely that the ratio of desired money holdings to planned spending is much higher for consumption than investment. Money demand should therefore be a function of private sector consumption spending–and nominal interest rates–not a function of income. We thus have:

C = MV(i)/P

Y = C + I + G + (X-M)

And from this accounting framework it is very difficult indeed to make strong monetarist conclusions appear obvious facts of nature rather than weird and tendentious claims. Mankiw and Summers made this point back in 1982. And they were totally ignored—even though it was and is a very smart point…